Why many mutual funds fail to perform?

Mutual fund is a wonderful financial instrument for people who have neither time nor the inclination to test their understanding of the stock market. It helps people with a very small amount of money to diversify their portfolio to minimize the risk. But even then quite often amateurs easily outperform many mutual funds. In fact in long run most of the mutual funds underperform in comparison to their respective benchmark index.

As Peter Lynch says, this is not because of the inability of the fund managers, but it is the inherent fear of losing. Success is one thing, but it is more important not to look bad if you fail. Managers are quite aware that if they lose even 20-30% of investors’ money on company like Reliance, people will question Reliance for its failure than the manager to predict such movement. But a 10% loss on IFCI could call for reasoning behind such investment. It is better to fail on conventional stocks to keep the job safe than to try unconventional stocks and brings the job in jeopardy. That is the reason why most of the fund managers keep looking for reasons not to buy exciting stocks.

The other issue with mutual fund is the fee that management charges to their investor for managing their fund. An entry load of 2.25% brings down the returns by a significant level and again the exit load (In case of most of the mutual funds) of 2.25% further takes away return from the investors. According to Buffet, in Wall-Street, such management fund causes mutual funds giving less than 80% of return in comparison to the index funds.

Another hurdle with mutual fund is the regulation imposed by monitoring authority like Security and Exchange Board of India (SEBI). The upper cap of stake on a particular stock forces fund managers to look for some less attractive stocks than to increase stake on stocks which are bound to give better returns. Specially, in case of Small-Cap, size prevents manager to buy in such companies, because it is not possible to buy enough shares to have noticeable improvement in fund’s performance.

In such a situation, one of the alternative investors could think of is putting money in index funds, which do not need any management and hence can save the entry and exit load. Index funds are kind of exchange traded fund, where individuals’ money is put in different constituents on the index in proportion to their weight in the index. For example the index fund of NIFTY consists of 50 stocks which are constituent of S&P CNX NIFTY, and the money invested in this index-fund is proportionally distributed among these 50 stocks. One can also look for funds which have outperformed the index consistently in past 3 to 5 years. There are a few good mutual-funds which have beaten the index by a significant difference and hence preferred even after the management fee. More importantly, an individual needs to look at the fund-managers’ performance rather than the funds’ performance. As change of management could lead to change in ideology and can have impact on returns as well.

Stock Markets Unwinded

Here comes an article which will let you know the basics of a stock market. So let’s straight away start the topic which I think is of interest to everyone in the country.

First of all for those who think that stock markets are the easiest ways to become rich, think twice as it is one of the most troublesome places. It can make one earn a crore a day and loose two the next day. So with this constraint in mind let’s try and know our markets a bit better.

Let’s start with what does bulls and bears mean. Bulls mean people who purchase stocks and bear the one who sells them. All of you must have heard of about market indices as BSE Sensex or Nifty. One see’s the value of indices jumping up and down throughout the day. What does the value mean? If we take example of BSE Sensex it is the weighted average of thirty stocks which are representative of all the sectors of the economy. Thus these indices change with the change in the underlying stock prices. The next question which must be floating in your mind is what causes the change in stock prices. Well there are several factors which can cause a change in the stock price. Some of them are:

1. Recession in the economy or industry
2. Lower than expected performance of the company
3. Getting a new contract
4. News of its merger or its acquisition

Seeing the factors listed above don’t one get a feeling that these factors are transient and one most see the long term growth prospects of the company. Well my friends the stock markets are driven by something known as “Market Sentiments”. Mostly these sentiments don’t take into account long term growth prospects of a company but are driven mostly by the things happening right know in the company or industry or economy of the country or the global economy as a whole.

Further, I would also like to add that demand and supply, which are yet again governed by the market sentiments play a huge part in deciding the price of the stock and in turn the index value.
Now as we have learnt about the stock price movements and index value movements let us move into a bit more detail to understand the kind of markets prevalent in the country. Now the place where shares do get traded are known as Capital Markets. These can further be classified into primary markets and the secondary markets. The primary market is one where the Initial public offer (IPO) of a company i.e. shares for the first time are on offer while secondary market includes the place where day to day trading happens. Now a few of you must be having doubts about how does the price of an IPO is decided as the share is still not out in the market. Well it a complex process and will discuss about it in the next article. So let’s wind up this article now and will be back with more articles related to the vibrant world of stock markets very soon.